1/28/2010 @ 4:00PM

Bill Gross Channels Johnny Cash

Bill Gross, manager of the world’s largest mutual fund, recently put the U.S. in the same circle with struggling Greece, Japan and Italy. Pimco’s celebrated money manager labeled it “The Ring of Fire,” a collection of eight countries whose growing debt burdens, he says, make them especially vulnerable to weak economic growth this year.

France, Spain, Ireland and the U.K. account for the rest.

The U.S. wound up in the ring because Gross says its public debt has the potential to surpass 90% of economic output, or gross domestic product, a result of rising budget deficits and years of weak growth. The ratio currently sits at 86.6%, well below Greece, Italy and Japan.

A test of Gross’s argument comes Friday, when the U.S. Department of Commerce announces its first estimate of gross domestic product for the final three months of 2009. Economists surveyed by Thomson Reuters forecast that the economy expanded at a 4.6% annual rate. That would be the fastest growth it has had in more than three years.

In his February investment outlook the always colorful Gross expands the Pimco “new normal” argument. The “new normal” posits that the aftermath of the banking crisis will have a lasting grip on the U.S. and other developed countries as companies and people continue to curtail spending and shed debts. This change in spending–along with a surge in government borrowing, as debt shifts from the private sector to the public–will cause falling returns on investments and sluggish growth.

Gross plucked the 90% debt-to-GDP threshold from Carmen Reinhart and Kenneth Rogoff’s recent book, This Time Is Different, a study of financial crisis over 800 years. He cites it as the source for saying that when countries hurdled that 90% mark they knocked 1% off economic growth.

Of all the developed countries, “the U.K. is a must to avoid,” Gross writes. “Its Gilts [government bonds] are resting on a bed of nitroglycerine. High debt with the potential to devalue its currency present high risks for bond investors.” He likes Canada, where banks managed to avoid the U.S. housing crisis and budget deficits look relatively tame.

The U.S. has $12.3 trillion in total public debt and climbing. On Thursday the Senate voted to lift the Treasury’s borrowing limit to $14.3 trillion.

Earlier in the year Gross bought preferred shares of struggling banks like
Citigroup
and
AIG
. He also loaded his Pimco Total Return Fund up with
Fannie Mae
bonds. The fund is up 13.6% for the last year, more than double the performance of the
Barclays
(nee Lehman) Agg.